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Flexible Spending Account (FSA)

Flexible Spending Account (FSA)

What is an FSA (Flexible Spending Account)?

A Flexible Spending Account is a type of savings account that provides specific tax benefits to the account holder. An FSA sometimes referred to as a "flexible spending contract," is defined by an employee's employer. The account enables you to contribute a portion of your regular income to pay for eligible medical and dental expenses.

Another type of FSA is a flexible dependent care expense account, which is used to pay for the care of children under 12 and can also pay for qualifying adult care, including a spouse, who cannot afford to take care of themselves and comply with specific Internal Revenue Service (IRS) rules. An FSA for dependents has maximum contribution rules that differ from a flexible health-care expense account.


Points to Note

  • An FSA is more of a savings account that enables employees to contribute a portion of their regular income to pay for eligible expenses.

  • Funds paid into your account are deducted from your income before being subject to payroll tax.

  • Money in an FSA must be used before the end of the plan year, but employers can offer a grace period of up to two and a half months until March 15 of the following year.


How a Flexible Spending Account (FSA) Works

One of the main benefits of a flexible spending account is that the funds deposited into your account are deducted from your pre-tax income, which reduces your taxable income. Therefore, regular contributions to an FSA can significantly reduce your annual tax debt.

The IRS limits the annual amount that can be paid into an FSA account. For FSA medical bills, the 2020 limit per employee is $ 2,750. If you are married, your spouse can waive this limit through his/her employer. Employers can decide to contribute to an FSA but are not required to do so; their contribution will not reduce the amount you can contribute if they do.


Is Health Reimbursement Arrangement (HRA) the same as Flexible Expense Account (FSA)? 

No. One of the main differences between HRA and FSA is the source of funding. HRAs are funded exclusively through employer contributions, while the employee typically funds FSA, usually through pre-tax deductions. However, you can have both accounts. If you have an HRA and an FSA, eligible expenses for both accounts will usually be reimbursed first by the FSA and, by default, to the HRA. 


What is the difference between a Dependent Care FSA and Health Care FSA?

Even with the best health insurance, you will likely have expenses out of pocket every year. If you have kids and need to pay for child care, a dependent care account can help you increase your hard-earned money. There are two types of FSA:

  • A Dependent Care FSA, also known as the Dependent Care Assistance Program (DCAP), covers employment-related expenses for childcare. The eligible expenses must relate to the services which allow you to go to work. This account's typical expenses include child care, kindergarten, and senior (but not health-care) expenses for their legal tax employees.

  • Health care FSA can cover any medical, dental, or vision expenses you would pay out of pocket. Common eligible expenses generally covered by a health care FSA include health insurance deductibles, coinsurance or co-payment, glasses or contact lenses, dental and orthodontic care, medical equipment, hearing aids, and chiropractic care. Many over-the-counter medications, such as cold and allergy medications, pain relievers, and antacids, can also be covered by an FSA. Your employer can limit the expenses reimbursed by the plan.


Advantages and Disadvantages of Flexible Expense Accounts (FSA)

FSA funds can be used to pay for certain medical, dental, and vision expenses, including dependents and spouses. The funds in the account can also be used to cover deductibles and copay in providing medical services. Unfortunately, money cannot be used to pay for insurance premiums.

Purchases of medical equipment, such as diagnostic devices, bandages, and crutches, may be covered by the FSA. Concerning medications, it was customary to take over-the-counter medications as well as insulin, prescribed or not. However, the CARES Act says you can now use the FSA to pay for over-the-counter drugs, including those needed for quarantine and secondment, social over-the-counter. The law also extends FSA funds for menstrual care products, and both provisions are permanent.

The recent $2 billion CARES Act expanded the APP coverage to include over-the-counter drugs and over-the-counter menstrual care products, and the provisions are permanent.


Tax savings for flexible expense accounts

Since the money used to fund the FSA is pre-tax, deduct it from your pre-tax salary, you get to save any percentage you would have paid for that money in federal taxes.


Suppose you earn $ 50,000 per year. If you sign up for the flexible spending account benefit and contribute $ 2,000 to an FSA account, if your tax rate is 30%, you will get a benefit of $ 600.


Use it or lose it

Alternatively, you don't want to think of FSA as a savings account. This is a medical benefit designed to fund annual medical costs out of pocket. You can lose all the unspent money in your account at the end of the year.

However, the rule of use-it-or-lose-it is not carved on stones. The Internal Revenue Service offers employers the option of allowing employees until March 15 of the following year to use FSA funds from the previous year.

The IRS also allows employers to allow their employees to accumulate up to $ 500 in unused FSA cash the following year. These are options available to employers and not rules, so check your company policies. 


Special considerations

In general, all money allocated to an FSA must be used before the end of the plan year. However, employers can allow a grace period of up to two and a half months to stop using these funds.

If this option is not selected, employers can allow you to transfer more than $ 500 per year of unused funds to your account. No option is required, but only one can be offered.

When the grace period ends or expires, all remaining FSA funds are forfeited. Therefore, you need to carefully calibrate how much money you plan to put into your account and how you plan to spend it throughout the year.


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